Universal Default: What It Is and How to Beat It

If you pay your credit card bill late, you shouldn't be surprised to see your interest rate go up. But many cards also have a "universal default" clause, which means your bank can hike your rate if you make a late payment anywhere.

Essentially, the universal default clause allows credit card issuers to raise your interest rate if you default on any of your outstanding credit obligations. (That is, if you're more than 30 days late on a payment.) Even if you have never been late paying on that particular card, your rate can still be affected by late payments to other creditors. For many credit card holders these penalty rate increases occur without warning or explanation.

The good news? The new credit card legislation signed last week puts an end to universal default. The bad news? That law doesn't go into effect until February 2010.

Credit card issuers began inserting universal default clauses in their agreements in the mid- to late 1990s after a wave of bankruptcies. In the interim years, virtually anyone could get a credit card (sometimes with very low introductory interest rates) regardless of his or her credit worthiness.

Now, when a credit card holder shows signs of financial difficulty, universal default allows issuers to change the terms of the credit card agreement to increase the interest rate. It's a way to address the risk retroactively.

Almost anything can trigger a universal default rate increase. Of course, a late mortgage payment or a late payment to another credit card will suffice, but even a late payment on your phone bill or water bill might also do the trick. When the rate increases, it becomes whatever the pre-determined universal default rate is, which can be as high as 29.99%. It doesn’t matter what your rate was at the time of the default. Even if you are in a period of 0% interest, your rate can go up with a universal default clause.

The effect of a universal default rate hike can be dramatic if you carry a large balance on your credit card. For some, the rate can go up 20% in one jump. If you have a credit card with a balance of $5,000 on it, that would equal an additional $1,000 a year. With the current state of the economy, this practice can be even more burdensome for families than it has been in previous years.

If you’ve never heard of the universal default clause, you’re not alone. The terms are often buried in the fine print of your credit card agreement, and many consumers either don’t fully read these agreements or don’t understand the language. It's growing resentment over these unseemly practices that led Congress to pass, and President Obama to sign, a new law that will end universal default and restrict the circumstances under which banks can hike your interest rate, among other things.

But you can be sure that credit card companies will try to get as much money out of you as they can before the law goes into effect in February. Until then, there are some things you can do to protect yourself from having your rates raised out of the blue.

First, check the terms and conditions of your credit card agreements carefully to determine which ones have universal default clauses. Next, organize your finances so that you don’t make any late payments. Paying bills when you receive them rather than waiting until they are due can help. An even better way to avoid late payments is to set up automatic online bill pay so you never have to worry about overlooking a bill.